Managing the J-Curve of Private Markets – one of the advantages of semi-liquid structures

We launched Carmignac Private Evergreen one year ago, driven by our strong conviction in the Private markets have historically been reserved for large institutional investors due to the typically high minimum investment level and complex cash management of closed-end structures. Accessing quality fund managers has proved difficult unless there were significant sums to deploy and a deep knowledge of private market asset managers. Recently, fund managers have started to adopt other structures to offer access to private market assets, with one of the most popular being semi-liquid or evergreen funds.

Operating like a mutual fund, usually in the form of a SICAV domiciled in Luxembourg and subject to the alternative investment fund regime, evergreen funds have developed to satisfy the growing interest in private markets from different types of investors, each with different resources and preferences, but nevertheless keen to tap into the opportunities across this large and diverse investment universe.

To understand what changed, it is important to go back to the early situation of investing in closed-end funds. One of the drawbacks that investors have previously faced in private markets is the so-called “J-curve” effect, whereby net returns are initially negative when capital is called for investments and fees. These investments will take a while to appreciate as it takes some time to invest the capital and generate returns, as shown in the chart below from years 1 to 4. This effect may make this closed-end fund structure less suitable for many investors, especially when the structure may mean that capital is locked in for the entire term of the fund, which can be up to 12 years. Additionally, investors face the administrative burden of managing progressive capital calls and reinvesting distributions, unlike an evergreen fund structure, where capital can be invested and returns enjoyed almost immediately.

NET PERFORMANCE EVOLUTION OF A CLOSED-END FUND (TVPI)

With an evergreen fund, 100% of capital is called from day one: investors are immediately exposed to a portfolio of private companies and can benefit from the appreciation of investments already made in the fund. This mitigates the J-curve effect seen with closed-end funds. A positive return could even be possible within a month of the investment if existing investments appreciate in value.

This J-curve mitigation can be further reinforced by investing in certain sub-asset classes of private equity, such as secondary investments. Secondary transactions allow a portfolio to be acquired at a discount (e.g. 90 pence), which would generate an increase in yield from day one, as the assets are recognised at their NAV (1 pound). And it doesn’t stop there – returns would continue to rise thanks to the revaluation of the underlying investments, beyond the mere positive impact of the discount (e.g. an asset being worth £1.1 vs. £1 on day one at a cost of 90 pence).

Evergreen funds have the potential to improve returns thanks to their unique structure. They allow for total liquidation from day one, and distributions are reinvested with the same annual return objective. This allows investors to benefit from the full effects of capitalisation on their investments, all under the management of a team of experts.

COMPOUNDED PERFORMANCE OF EVERGREEN FUNDS

It’s important to note that closed-end funds typically use the internal rate of return (IRR), which only accounts for returns on the actual invested amount, represented on the chart on the left. This invested amount often represents a fraction of the total capital committed, averaging around 60% over the life of the fund. Commitments that have not yet been invested remain as cash held by the investor and will be subject to a different return, depending on the investor's liquidity management capabilities and experience. In contrast, evergreen funds use the annual return metric, calculated on the basis of the total amount called from day one, represented on the chart on the right.

Evergreen funds also offer other advantages, such as the absence of a fixed term. With the ability to subscribe to the fund at any time and the possibility of subscriptions and redemptions periodically, these funds offer an advantage that is highly valuable even to institutional investors who already have access to traditional closed-end funds: liquidity windows and flexibility to manage their own allocation to private markets.

Evergreen funds play an important role in allowing all types of investors to access the attractive opportunities in private equity. Investors can entrust their capital to asset managers that have the required expertise, knowledge and access to private markets, together with a stringent risk management framework, that enable the creation and ongoing management of sound and diversified portfolios. At Carmignac, our investment team has built a robust portfolio of private equity companies, with attractive valuation metrics, high profitability and sustained growth prospects. Accessible from a minimum subscription of £10,000, the Carmignac Private Evergreen fund adopts an evergreen structure while investing mostly in secondary transactions, which we think offers investors an attractive access point to private companies, to satisfy their need for liquidity and flexibility.